Nature and Scope of Macroeconomics (Part - 2) - Macro Economics | Macro Economics - B Com PDF Download

5. Macro Statics, Macro Dynamics and Comparative Statics:

Micro Statics:

The word ‘statics’ is derived from the Greek word statike which means bringing to a standstill. In physics, it means a state of rest where there is no movement. In economics, it implies a state characterised by movement at a particular level without any change. It is a state, according to Clark, where five kinds of changes are conspicuous by their absence.

The size of population, the supply of capital, methods of production, and forms of business organisation and wants of the people remain constant, but the economy continues to work at steady pace. “It is to this active but unchanging process,” writes Marshall, “that the expression static economics should be applied.” Static economy is thus a timeless economy where no changes occur and it is necessarily in equilibrium. Indices are adjusted instantaneously: current demand, output and prices of goods and services.

As pointed out by Prof. Samuelson “Economic statics concerns itself with the simultaneous and instantaneous or timeless determination of economic variables by mutually interdependent relations.” There is neither past nor future in the static state. Hence, there is no element of uncertainty in it. Prof. Kuznets, therefore, believes that “static economics deals with relations and processes on the assumption of uniformity and persistence of either the absolute or relative economic quantities involved.”

Macro-statics analysis explains the static equilibrium position of the economy. This is best explained by Professor Kurihara in these words, “If the object is to show a ‘still picture’ of the economy ii a whole, the macro-static method is the appropriate technique. For this technique is one of investigating the relations between macro-variables in the final position of equilibrium without reference to the process of adjustment implicit in that final position.” Such a final position of equilibrium may be shown by the equation

Y = C + I.

Where Y is the total income, C is the total consumption expenditure and I, the total investment expenditure.

It simply shows a timeless identity equation without any adjusting mechanism. This macro-static model is illustrated in Figure 1.

According to this static Keynesian model, the level of national income is determined by the interaction of aggregate supply function and the aggregate demand function, In the Figure, 45° line represents the aggregate supply function and C + I line, the aggregate demand function, 45° line and C + I curve intersect at point E, the point of effective demand which determines OY level of national income.

Thus, economic statics refers to a timeless economy. It neither develops nor decays. It is like a snapshot photo from a ‘still’ camera which would be the same whether the previous and subsequent positions of the economy were subject to change or not.

Macro Dynamics:

Economic dynamics, on the other hand, is the study of change, of acceleration or deceleration. It is the analysis of the process of change which continues through time.

An economy may change through time in two ways:

(a) Without changing its pattern, and

(b) By changing its pattern.

Economic dynamics relates to the latter type of change. If there is a change in population, capital, techniques of production, forms of business organisation and tastes of the people, in any one or all of them, the economy will assume a different pattern, and the economic system will change its direction.

In the accompanying diagram, D given initial values of the economy, it would have proceeded along the path AB, but suddenly at A the indices change the pattern, and the direction of the equilibrium changes towards C. Again, it would have proceeded to D but at C the pattern and direction is changed to E. Thus, economic dynamics studies the path from one equilibrium position to another: from A to C and from C to E.

Economic dynamics is, therefore, concerned with time-lags, rates of change, and past and expected values of the variables. In a dynamic economy, data change and the economic system take time to adjust itself accordingly. According to Kurihara, “Macro-dynamics treats discrete movements or rates of change of macro-variables. It enables one to see a ‘motion-picture’ of the functioning of the economy as a progressive whole.”

The macro-dynamic model is explained in terms of the Keynesian process of income propagation where consumption is a function of the income of the preceding period, i.e., C_t=f (Y_t-1) and investment is a function of time and of constant autonomous investment ΔI, i.e., I₁= f (ΔI).

In Figure 2, C +1 is the aggregate demand function and 45° line is the aggregate supply function. If we begin in period t_o where with an equilibrium level of income OY₀, investment is increased by ∆I, then in period t income rises by the amount of the increased investment (from t₀ to t). The increased investment is shown by the new aggregate demand function C+I+∆I.

But in period t, consumption lags behind, and is still equal to the income at E₀. In period t + I, consumption rises and along with the new investment, it increases income still higher to OY₁.

This process of income propagation will continue till the aggregate demand function C + I + ΔI intersects the aggregate supply function 45° line at E_n in the nth period, and the new equilibrium level is determined at OY_n. The curved steps t₀ to E_n show the macro-dynamic equilibrium path.

Comparative Statics:

Comparative statics is a method of economic analysis which was first used by the German economist, F. Oppenheimer in 1916. Schumpeter described it as “an evolutionary process by a succession of static models.” In the words of Schumpeter, “Whenever we deal with disturbances of a given state by trying to indicate the static relations obtaining before a given disturbance impinged upon the system and after it had had time to work itself out. This method of procedure is known as Comparative Statics.” To be precise, comparative statics is the method of analysis in which different equilibrium situations are compared.

A <——–> B

The distinction between static, comparative static and dynamic situations is explained with the help of the accompanying figure. If the economy is working at situation A where it is producing at a constant rate without any change in the variables, it is a static state which is functioning at a point of time.

When the economy moves from the equilibrium point A to point B through time, it is economic dynamics which traces out the actual path of movement of the economy between the two static equilibrium points.

Comparative statics, on the other hand, is related to once-over change from point A to point B in which we do not study the forces behind the movement between the two points. Thus comparative statics is not concerned with the transitional period but “involves the study of variations in equilibrium positions corresponding to specified changes in underlying data.”

The Keynesian employment, income and output analysis is also based on the theory of shifting equilibrium wherein it compares different equilibrium levels of income. According to Kurihara, Keynes made no attempt to show the process of transition from one position of equilibrium to another. He simply used comparative statics analysis.

Figure 3 explains two different levels of income, OY₂ at OT₁ time and OY₁ at OT₂ time. Independent of each other both the income levels relate to economic statics. But income at OY₂ level is higher than at OY₁ level. This is comparative statics which compares two static levels of income as against dynamic economics which traces out the path AB, showing increase in income.

Limitations:

But comparative statics is not without limitations;

1. Its scope is limited for it excludes many important economic problems. There are the problems of economic fluctuations and growth which can only be studied by the method of dynamic economics.

2. Comparative statics is unable to explain the process of change from one position of equilibrium to another. It “gives only a partial glimpse of the movements, for we have only the two ‘still pictures’ to compare, whereas dynamics would give us a movie.”

3. We are not sure when the new equilibrium will be established because this method neglects the transitional period. This makes comparative statics an incomplete and unrealistic method of economic analysis.

Conclusion:

We sum up the discussion among macro statics, macro dynamics and comparative statics thus: Economic statics is the study of relations between economic variables at a point of time, whereas economic dynamics explains the relationship of economic variables through time.

In a static economics there is movement but no change in economic phenomena while in dynamic economics, the fundamental forces themselves change. The former studies movement around the point of equilibrium, but the latter traces the path from one point of equilibrium, to the other, both backward and forward.

On the other hand, comparative statics studies and compares two static equilibrium positions. If savings at a point of time are S₁ and at another moment of time S₂, this is once over change which is comparative statics. But if a given rise in savings leads to increase in investment, output, income and to a further rise in savings, this sequence of interdependent events of continuous changes is dynamic in nature.

No doubt economic dynamics is the antithesis of economic statics, yet the study of dynamic economics is a necessary adjunct to the hypothetical static analysis to enable economists to formulate generalisations. The raison d’etre of all static investigations is the explanation of dynamic change.

On the other hand, dynamic economics is made up of static situations. If economic dynamics is the running picture of the working of the economy, economic statics relates to the ‘still’, the stationary position of the economy. Thus, both economic dynamics and economic statics are essential for the study and solution of economic problems.

6. Transition from Microeconomics to Macroeconomics:

As methodological approaches, both microeconomics and macroeconomics were used by the classical and neo-classical economists in their writings. But it was Marshall who developed and perfected microeconomics as a method of economic analysis.

Similarly, it was Keynes who developed macroeconomics as a distinct method in economic theory. Therefore, the actual process of transition from microeconomics to macroeconomics started with the publication of Keynes’s General Theory. This transition has taken place in the following branches of economics.

Microeconomics is the study of economic actions of individuals and small groups of individuals. It includes particular households, particular firms, particular industries, particular commodities, individual prices, wages, and incomes.

Thus microeconomics studies how resources are allocated to the production of particular goods and services and how efficiently they are distributed. But microeconomics, in itself, does not study the problem of allocation of resources to the economy as a whole. It is concerned with the study of parts and neglects the whole.

As pointed out by Boulding, “Description of a large and complex universe of facts like the economic system is impossible in terms of individual items.” Thus the study of microeconomics presents an imprecise picture of the economy. But the orthodox economists, like Pigou, tried to apply microeconomic analysis to the problems of an economy.

Keynes thought otherwise and advocated macroeconomics which is the study of aggregates covering the entire economy such as total employment, total income, total output, total investment, total consumption, total savings, aggregate supply, aggregate demand, and general price level, wage level and cost structure. For understanding the problems facing the economy, Keynes adopted the macro approach and brought about the transition from micro to macro.

Microeconomics assumes the total volume of employment as given and studies how it is allocated among individual sectors of the economy. But Keynes rejected the assumption of full employment of resources, especially of labour.

From the macro angle, he regarded full employment as a special case. The general situation is one of underemployment. The existence of involuntary unemployment of labour in capitalist economies proves that underemployment equilibrium is a normal situation and full employment is abnormal and accidental.

Keynes refuted Pigou’s view that a cut in money wage could eliminate unemployment during a depression and bring about full employment in the economy. The fallacy in Pigou’s argument was that he extended the arguments to economy which were applicable to a particular industry.

Reduction in money wage rate can increase employment in an industry by reducing its cost of production and the price of the product thereby raising its demand. But the adoption of such a policy for the economy leads to a reduction in employment. When money wages of all workers in the economy are reduced, their incomes are reduced correspondingly. As a result, aggregate demand falls leading to a decline in employment in the economy as a whole.

Microeconomics takes the absolute price level as given and concerns itself with relative prices of goods and services. How the price of a particular commodity like rice, tea, milk, fan, scooter, etc. is determined? How the wages of a particular type of labour, interest on a particular type of capital asset, rent on a particular land, and profits of an individual entrepreneur are determined? But an economy is not concerned with relative prices but with the general level of prices.

And the study of the general level of prices falls within the domain of macroeconomics. It is the rise or fall in the general price level that leads to inflation, and to prosperity and depression. Prior to the publication of Keynes’s General Theory, economists concerned themselves with the determination of relative prices and failed to explain the causes of inflation and deflation or prosperity and depression.

They attributed the rise or fall in the price level to the increase or decrease in the quantity of money. Keynes, on the other hand, showed that deflation and depression were caused by the deficiency of aggregate demand, and inflation and prosperity by the increase in aggregate demand. It is thus the rise or fall in aggregate demand which affects the general price level rather than the quantity of money.

Moreover, microeconomics being based on the assumption of full employment, it failed to provide an adequate explanation of the occurrence of trade cycles. It could not explain the turning points of the business cycles. By discarding the unrealistic assumption of full employment, Keynes and his followers have built models which not only explain the macroeconomic forces lying behind cyclical fluctuations but also explain the turning points of the cycle.

Another factor which has led to the transition from microeconomics to macroeconomics is the failure of microeconomics to deal with problems relating to the growth of the economy. Microeconomics concerns itself with the study of individual household, firm or industry.

But principles which are applicable to a particular household, firm or industry may not be applicable to the economy as a whole. This is because the level of aggregation differs in micro theory from macro theory. The classical economists committed the folly of applying micro theory to the economy as a whole while explaining economic growth.

They emphasised the importance of saving or thrift in capital formation for economic growth. But in macro theory saving is a private virtue and a public vice. This is because increase in aggregate saving leads to a decline in aggregate consumption and demand, thereby decreasing the level of employment in the economy.

Therefore, to remove unemployment and bring economic growth require increase in aggregate investment rather than saving. For economic growth, Harrod and Domar have emphasised the dual role of investment. First, it increases aggregate income, and second, it increases the productive capacity of the economy.

Microeconomics is based on the laissez-faire policy of a self-adjusting economic system with no government intervention. The classical economists were the votaries of laissez-faire policy. They believed in the automatic adjustment in the malfunctioning of the economy.

They, therefore, had no faith either in monetary policy or fiscal policy for removing distortions in the economy. They also believed in the policy of balanced budgets. Keynes, who brought about the transition from micro to macro thinking, discarded the policy of laissez-faire.

He believed that such a policy did not operate in public interest and it was this policy which had led to the Great Depression of 1930s. He, therefore, favoured state intervention and stressed the importance of deficit budgets during deflation and surplus budgets during inflation, along with cheap money and dear money policies respectively. The Keynesian policy measures have been adopted along with direct controls by the capitalist countries of the world.

7. Stock and Flow Concepts:

The aggregates of macroeconomics are of two kinds. Some are stocks, typically the stock of capital K which is a timeless concept. Even in period analysis, a stock must be specified at a particular moment. Other aggregates are flows such as income and output, consumption and investment. A flow variable has the time dimension t, as per unit of time or per period.

Stock is the quantity of an economic variable relating to a point of time. For example, store of cloth in a shop at a point of time is stock. Flow is the quantity of an economic variable relating to a period of time. The monthly income and expenditure of an individual, receipt of yearly interest rate on various deposits in a bank, sale of a commodity in a month are some examples of flow. The concepts of stock and flow are used in the analysis of both microeconomics and macroeconomics.

In Microeconomics:

In price theory or microeconomics, the concepts of stock and flow are related to the demand for and supply of goods. The market demand and supply of goods at a point of time are expressed as stock. The stock- demand curve of good slopes downward from left to right like an ordinary demand curve, which depends upon price.

But the stock-supply curve of a good is parallel to the Y-axis because the total quantity of stock of a good is constant at a point of time. On the other hand, the flow-demand and supply curves are like the ordinary demand and supply curves which are influenced by current prices. But the price is neither a stock nor a flow variable because it does not need a time dimension. Nor is it a stock quantity. In fact, it is a ratio between the flow of cash and the flow of goods.

In Macroeconomics:

The concepts of stock and flow are used more in macroeconomics or in the theory of income, output, and employment. Money is a stock whereas the spending of money is a flow. Wealth is a stock and income is a flow. Saving by a person within a month is a flow while the total saving on a day is a stock. The government debt is a stock but the government deficit is a flow. The lending by a bank is a flow and its outstanding loan is a stock.

Some macro variables like imports, exports, wages, income, tax payments, social security benefits and dividends are always flows. Such flows do not have direct stocks but they can affect other stocks indirectly, just as imports can affect the stock of capital goods.

A stock can change due to flows but the size of flows can be determined itself by changes in stock. This can be explained by the relation between stock of capital and flow of investment. The stock of capital can only increase with the increase in the flow of investment, or by the difference between the flow of production of new capital goods and consumption of capital goods.

On the other hand, the flow of investment itself depends upon the size of capital stock. But the stocks can affect flows only if the time period is so long that the desired change in stock can be brought about. Thus, flows cannot be influenced by changes in stock in the short run.

Lastly, both the concepts of stock and flow variables are very important in modern theories of income, output, employment, interest rate, business cycles, etc..